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What the DHFL default rating means for Scripbox investors

On 3 June 2019, DHFL failed to repay the amounts due against some of its borrowings. This put under doubt its ability to repay its other borrowings. As a result the rating agencies downgraded the rating of DHFL borrowings to default.

Dewan Housing Finance Corporation Ltd (DHFL) is a large housing finance company which has used bonds to raise money for its lending activities. These bonds were held by financial institutions including debt mutual funds. These bonds are like FDs which mature on a certain date and the borrower (DHFL in this case) has to repay the amount.

On 3 June 2019, DHFL failed to repay the amounts due against some of its borrowings. This put under doubt its ability to repay its other borrowings. As a result the rating agencies downgraded the rating of DHFL borrowings to default.

What does the rating downgrade mean to investors in mutual funds that were holding DHFL bonds?

When a bond is downgraded, the mutual funds have to reflect the possibility of loss by reducing the value of their holdings. This leads to a drop in NAV. On June 4th, NAVs of many mutual funds holding DHFL bonds fell.

Did all mutual funds suffer the same loss?

No. The loss of NAV depends on the amount of DHFL bonds held by the mutual fund as a proportion of its total assets. Some of the smaller funds which held a disproportionately high amount of DHFL bonds were badly affected. Larger funds with low concentration of DHFL bonds were impacted much less.

Scripbox performs due diligence before recommending a fund. Our algorithm looks at the growth track record of a debt fund as well as the quality of its holdings.

As an investor with Scripbox, what is the impact on my investments.

Only one of the funds in our investors’ portfolios  - Nippon India Low Duration Fund - was impacted. The NAV of the fund fell by 1.9% due to this.

We had previously recommended to our investors that they should exit all long term holdings (more than 3 years)  in this fund and many did.

Does the downgrade mean there is no possibility of repayment?

No. The downgrade reflects a probability. A company may make arrangements to repay its debt by selling its other assets. If repayment happens, the mutual fund asset value will go up. Since the events of 3 June, DHFL repaid its bonds owned by 2 mutual funds and the NAV of these funds was restored.

Should I continue to hold Nippon India Low Duration Fund

Our recommendation is to exit long term holdings and continuing to hold short term investments. The fund has performed well historically - returning 7-8% per annum - and does not have high concentration of a specific company.

Could Scripbox have prevented this for its investors?

Scripbox performs due diligence before recommending a fund. Our algorithm looks at the growth track record of a debt fund as well as the quality of its holdings. The algorithm also recommends only large funds where there is low concentration and therefore risk of default is managed. Both of these played a role in minimising the impact on Scripbox investors - compared to some other funds where the impact was 15-20%.

We also monitor the funds and make change recommendations as required. We had made a similar change for this fund ahead of the downgrade. A well managed fund recommended by us minimises risk for its investors.

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